Fear of the Evergrande collapse: “Social unrest will be hard to avoid”

Uncertain real estate giant Evergrande brings back memories of the 2008 financial crisis. Is Lehman 2.0 coming? The comparison is flawed, says Mirko Wormuth of the German-Chinese fund Awesome Capital. In an interview with Capital, a Chinese expert explains why the Beijing government needs to act and what it is likely to do.

Evergrande is now known as the Chinese “Lehman moment”. Would a group bankruptcy have equally devastating consequences?

Mirko Wormuth: The comparison between Lehman Brothers and Evergrande is not at all appropriate. The lessons learned from Lehman’s fall were so clear that business leaders, including Beijing’s technocratic ruling elite, would never repeat them. In this case, however, you can quickly get the impression that we are dealing with two realities: Chinese and media from the outside.

What is the reality in China today?

To do this, you need to look at the relevant stakeholders. About 1.4 million apartments have already been paid for, but in many cases not yet built. The buyers are now risking that these apartments will not be completed, despite high advance payments. In the face of possible social unrest, this is currently the greatest threat from the point of view of the Communist Party of China.

How?

Always remember that in China it is estimated that 80 to 90 percent of the population owns real estate. If Evergrande goes bankrupt and, at worst, takes other real estate companies with it, Beijing will find it hard to avoid civil unrest. Especially since recently the Communist Party has promised “universal welfare”, that is, everyone has a share of the wealth of society.

The banking sector is also concerned about many observers at the moment. What would bankruptcy mean there?

There, of course, bankruptcy would be felt, but the consequences would mainly affect domestic financial institutions. So here, too, the situation is not comparable to Lehman Brothers, as Lehman Brothers was extremely diverse in the US and world economies. On the other hand, Evergrande has 90 percent of its operations in China and therefore credit risk is limited nationally. For smaller banks, insolvency is indeed a serious problem, but for most medium-sized and large banks, loans – although they would, of course, be stuck in loans then – do not generally make up a large proportion.

How bad would the default be for Evergrande investors and investors?

Of course, they would have been hit, but that is always the risk of investing in stocks. Especially since the total losses would be rather small. About 70 percent of Chinese household wealth is real estate. Stocks are only one sixth. But it also has to do with the nature of the Chinese stock market, which – especially on the domestic stock exchanges in Shanghai and Shenzhen – is volatile and many Chinese consider investment unsafe.

Does that mean Evergrande will go bankrupt?

At first glance, debt of 2 trillion renminbi seems a lot – the company also has assets of 2.3 trillion renminbi – but compared to the Chinese economy, Evergrande only makes up about 2% of GDP. Moreover, the group only has a 4% market share. Therefore, this is not a size that would threaten the entire real estate sector. However, a sale could lower prices and thus pull other competitors down – and the government definitely does not want that.

What will KP do to limit the damage?

Beijing has already taken the first step when the central bank pumped $ 14 billion into the market last Friday – the highest amount in 14 to 15 months. But that does not mean that the state will now step in en masse. Restructuring is more likely, with state actors taking care of 1.4 million exceptional housing in particular. What such a restructuring package will ultimately look like can only be speculated for the time being.

Could Evergrande’s impending bankruptcy have been predicted when China announced “three red lines” for the real estate sector in August 2020?

Even then, there was no doubt that Evergrande, with debts of $ 300 billion, would exceed those limits. Therefore, all eyes are on the group from August 2020 and wonder how much longer it can go well, because it can hardly get out of this situation. At the same time, you always have to look at the “red lines” why KP is taking this step.

So why did she arrange these lines?

Real estate in China has become so expensive that most people can no longer afford their own home. The “three red lines” are intended to counteract this. At the same time, the real estate sector is responsible for 14 percent. GDP, with the entire upstream and downstream supply chain up to 29%. So KP is already aware of what this step means economically.

There were also regulations for tutoring and technology companies. For whom has KP introduced these measures?

What is happening with Evergrande and what laws have been put in place in the tech scene are two different things. Nevertheless, what all regulations have in common is that they are designed to protect specific groups. In the case of private tutoring companies, these are groups of parents and children. First of all, the pressure on students is so great that they still learn almost exclusively privately outside of school. This puts parents under enormous financial pressure. This step also comes with the cost of hundreds of thousands of jobs that KP has accepted to protect parents and children.

On top of that, there is antitrust law, which has hit big tech companies like Alibaba in particular …

Here, too, it is about protecting end consumers and small retailers who were patronized by large online platforms such as Alibaba. KP does not want Alibaba to be small, but to empower smaller suppliers. Incidentally, the US has the same problems with the big tech companies, even though the political situation in the US as a democracy is obviously different. But I have the impression that although this debate is still ahead of us, China is already one step further.

How?

Currently, KP is working its way through individual sectors, creating new regulations and developing mechanisms to ensure compliance with these rules. It is not about breaking down capitalist tendencies or entrepreneurship. In its latest five-year plan, which by the way also sets goals until 2035, China made it clear that you can’t achieve your goals alone with state-owned companies. They need private companies and their innovative strength. At the same time, you can see how Chinese technology companies have changed their position to step into this future with the government.

Even so, many investors are concerned because the regulations have caused prices to fluctuate significantly – for example in tech stocks. How do you see the markets in the medium term?

Of course, I expect Chinese investment prices to rise. In addition, you should look at the recent debate to see who is going and how. There is George Soros who attacked Blackrock with his investments in China. At the same time, however, Mark Mobius, Ray Dario and Catherine Wood make it clear that the “China is not fit for investment” argument is nonsense, given that 30% of the total number of crimes committed in the next few years is nonsense. global growth will come from China. Of course you have to be able to judge things properly. But anyone who pulls out of this market now will completely lose connection.

The interview first appeared on Capital.de.

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